What keeps futures contracts in line with the cash price of the underlying? (2024)

What keeps futures contracts in line with the cash price of the underlying?

What keeps future contracts in line with the cash price of the underlying? The futures price ought to be the cash price plus the costs of storage (plus the 'cost of carry', i.e, interest rates). It is arbitrage which keeps that pricing in line.

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What determines the price of a futures contract?

In short, the price of a futures contract (FP) will be equal to the spot price (SP) plus the net cost incurred in carrying the asset till the maturity date of the futures contract. Here Carry Cost refers to the cost of holding the asset till the futures contract matures.

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What is the relationship between cash and futures prices?

The relationship between the cash and futures price is known as the basis. In marketing, basis generally refers to the difference between a price in a particular cash market and a specific futures contract price. Basis “localizes” the futures price with respect to location, time, and quality.

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What is an underlying futures contract?

Underlying assets include physical commodities or other financial instruments. Futures contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. Futures can be used for hedging or trade speculation.

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What is the basis of the futures price cash price?

Basis is the difference between a local cash (or street) price and the futures market price for that commodity. Basis is calculated as cash price minus futures price.

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What does the future price depend on?

Futures pricing is dependent on various factors like interest, returns, and financing costs. One should understand how futures pricing works to plan their position in markets more efficiently.

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How does the price of a futures contract change?

A futures price is determined by the cost of its underlying asset and moves in sync with it. The cost of futures will rise if the cost of its underlying increases and will fall as it falls. But it is not always equal to the value of its underlying asset. They can be traded at different prices in the market.

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What is an example of an underlying contract?

For example, a corn futures contract derives its value from the actual underlying corn that can be delivered into the contract. An option on a future is no different in this regard, but the underlier is another derivative, namely the corn future, which in turn has actual corn as its underlier.

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What is the difference between futures and underlying assets?

In the case of stock indexes, the underlying asset is comprised of the common stocks within the stock market index. Index futures are contracts where investors can buy or sell a financial index today to be settled at a future date.

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What is the difference between cash price and futures price?

The spot price of a commodity is the current cash cost of it for immediate purchase and delivery. The futures price locks in the cost of the commodity that will be delivered at some point other than the present—usually, some months hence.

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What is the difference between the cash price and the futures price called?

basis. Tap the card to flip 👆 The difference between the cash price and the futures price for a commodity, i.e., Basis = Cash price - Futures price.

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Which futures contracts are settled in cash?

Most options and futures contracts are cash-settled. However, an exception is listed equity options contracts, which are often settled by delivery of the actual underlying shares of stock.

What keeps futures contracts in line with the cash price of the underlying? (2024)
Can you lose more money than you have in futures?

Can You Lose more Money Than You have in Futures? Yes, it is possible to lose more money than you initially invested in futures trading.

Why trade futures instead of cash?

Futures contracts are typically more liquid than cash assets, which can make them easier to buy and sell. However, this also means that the price of the asset can be more volatile. Cash trading may be a better option if you are looking for more stable prices.

What is the convergence of cash and futures prices?

Convergence is the movement in the price of a futures contract toward the spot or cash price of the underlying commodity over time. The price of the futures contract and the spot price will be roughly equal on the delivery date.

What moves futures prices?

The futures will move based on the section of the world that is open at that time, so the 24-hour market must be divided into time segments to understand which time zone and geographic region is having the largest impact on the market at any point in time.

Why are futures prices higher than spot prices?

It indicates that demand is higher than supply in the short term, causing futures prices to rise. Futures prices rise above spot prices because investors become comfortable paying more for the future assets. However, commodity and volatility funds are structured to buy short-term futures.

What is the difference between the futures price and the value of the futures contract?

The futures price is fixed at the start, whereas the value starts at zero and then changes, either positively or negatively, throughout the life of the contract.

How do futures contracts work?

A futures contract is a legally binding agreement to buy or sell a standardized asset on a specific date or during a specific month. Typically, futures contracts are traded electronically on exchanges such as the CME Group, the largest futures exchange in the United States.

What are the problems with futures contracts?

Expiration risk: Futures contracts have fixed expiration dates. If you don't close or roll over your position before expiry, you may face delivery obligations or cash settlement at an unfavourable price. Interest rate risk: Interest rate futures are sensitive to changes in interest rates.

Why are futures so volatile?

Because of the lower margin requirements for futures, there is greater leverage in the futures markets than in the securities markets. In short, the lower margin/higher leverage multiplies the effect of the existing price volatility.

Why are futures so liquid?

Futures are known as derivatives contracts, since their value is derived from the underlying asset that will be delivered. Futures are standardized and traded on regulated exchanges, making them highly transparent and liquid.

What are the basics of futures?

Basics of Futures Trading
  • A commodity futures contract is an agreement to buy or sell a particular commodity at a future date.
  • The price and the amount of the commodity are fixed at the time of the agreement.
  • Most contracts contemplate that the agreement will be fulfilled by actual delivery of the commodity.

What is the underlying asset for a derivative contract?

Derivatives are contracts, which convey the right/obligation to buy or sell a specified asset at a specified price at a specified future date. An underlying asset (or also called Commodity) of the derivative contract is the one that is to be bought or sold on a future date.

What is an example of an underlying cost?

Types Of Underlying Cost
  • Direct Material Costs: These are costs related to the raw materials used in production.
  • Depreciable Costs: These are the costs of tangible assets depreciated over time, like machinery or buildings.

References

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